State and Local Finances: Where We’re Going

Try a little party game in which you ask your
friends and neighbors where their tax dollars come
from and where they go. Most will probably know
their federal tax bite. They may also be able to tick
off major federal spending programs like Social
Security, Medicare, and national defense. It is likely
that few, however, will mention the nation’s 50
states and nearly 90,000 counties, cities, towns,
school districts, and other local agencies.

That omission is unfortunate because states and localities do much of the heavy lifting in our federalist system. Although the federal government raises more revenue, states and localities undertake more spending on domestic goods and services (that is, spending net of intergovernmental grants and national defense). They outspent the federal government in nine of the last 10 fiscal years and in most years since World War II (See Figure 1 in PDF).[1] The exception was 2009, when federal expenditures spiked in response to the Great Recession.

As most Americans are probably aware, the recession also put state and local governments through a fiscal wringer. States in particular suffered historic revenue declines, with taxes plummeting 17 percent in the second quarter of 2009 compared with a year earlier.[2] At the same time, spending pressures mounted for Medicaid and other public assistance programs.

The result was record state budget gaps, estimated at up to $430 billion through fiscal 2011.[3] In most states, lawmakers were called back to the bargaining table shortly after enacting a budget to find more revenue or spending cuts.[4] At the local level, revenue has been more stable but are starting to dip as state aid cuts take effect and property taxes increasingly reflect market values (See Figure 2 in PDF).[5]

Commentators frequently note that all states except Vermont are constitutionally or statutorily required to balance their budgets. Some requirements are looser than others, requiring the governor to propose, or the legislature to enact, a balanced budget rather than preventing a state from carrying over a deficit year to year. However, bond markets also tend to limit funds for deficit-related borrowing.

States and localities must therefore increase taxes or cut spending to balance their books. Those actions can harm vulnerable populations and shortcircuit a national economic recovery. States and localities are the nation’s largest employer — responsible for one out of seven jobs — and in most years they contribute a third percentage point in real annual GDP growth. In 2009, however, their contribution was negative.[6] Since the start of the recession, local governments have cut 241,000 jobs, and surveys suggest as many as 481,000 more cuts may be coming.[7]